Production Sharing Agreement

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Production Sharing Agreement

A Brief Introduction About the Production Sharing Contract

Production Sharing Agreement(PSC) is used in any industry prospection, extraction and exploration of mineral resources can be done in a specific area over a specific duration. Typically, as part of a production sharing contract, a government awards a company, or a group of companies, the right to extract oil or other resources. The oil company bears all the risks, financial initiatives, exploration costs, and refinement expenses.

The government permits the company to utilize the money for recovering its costs. Any money left as profit is then distributed between the government and the oil company. Governments generally introduce a cost stop which limits the amount of costs the company can recover from the sales revenue.

Who Takes the Production Sharing Agreement?

PSC contracts are drafted between a company that offers to extracts resources or minerals from a country’s jurisdiction. The government allots the field and permits the exploration or extraction of resources and share the profits. Awarding the area for exploration is also subject to the acts or laws passed to protect domestic sovereignty.

Purpose of the Production Sharing Agreement

PSA contracts are particularly helpful for governments that lack the expertise or the capital for the extraction of resources. It is also useful when the government wants to attract foreign companies and their investment into the country. The extraction of resources also provides additional revenue for the government which can then be used for various purposes. The purpose of a production sharing contract is to ensure that the government receives a guaranteed share of profits from the excavation and extraction process.

Contents of the Production Sharing Agreement

A standard production sharing agreement template contains the following terms

  • Details of the parties that are entering into the contract
  • Duration of the contract and the start date of the contract
  • Details of the acts and laws that the contract would be governed under
  • Responsibility of the financial resources that are required for the extraction of resources
  • Definitions of the various terms included in the contract
  • The nature of license and exploration lease granted to the parties
  • Relinquishment of rights over the property and the process of such relinquishment
  • A work program and an outline of the process that would be undertaken for extraction
  • The details of the management committee and the sharing of decision-making powers between the government and the company
  • Details of accounting and reporting that the company should undertake for extracted resources
  • General rights and obligations of the party
  • Government assistance required and any subsidies provided
  • Details of reporting for discovery, development, and production.
  • Method of measurement of the volume of resources found at the site
  • Protection of environment and relocation responsibilities.
  • Cost stop and recovery of cost limits
  • Details of sharing the profits received after recovering the costs
  • Any taxes, royalties or other payments that need to be made
  • Nature of sale – domestic or export and their suitable licenses
  • Valuation and currency exchange for sale and cost recovery purposes.

How to Draft the Production Sharing Agreement?

When drafting a PSA contract, certain points have to be kept in mind. Some of them are

  • The certainty of the existence of resources at the site
  • The volume of resources expected on the field
  • Risks inherent in the process.
  • Costs that have to be incurred in extraction
  • The profit sharing ratio
  • The sensitive nature of environment – whether it is protected or needs relocation
  • The extent to which capital and developmental costs can be recovered.
  • Nature of confidentiality and exclusivity of performance

Negotiation Strategy

Negotiation in these contracts happens generally for profit sharing ratio and the cost stop limit. The extent to which companies are allowed to recover their loss, or the extent to which they can retain their profits would be the main point of negotiation. In some cases, the government may place limitations on the sale of the resources. The contention of the sale limits could be a part of the negotiation as well.

[ Also Read: Mineral Lease and Coal Lease Agreement ]

Benefits and Drawbacks of the Production Sharing Agreement

There are several benefits for the host government and for the extracting party. Some of them are

  • The inherent risk of development is low for the host country
  • There is a knowledge transfer and transparency of process from the extraction company to the host country
  • Various cost recovery strategies can be employed by the parties for the expenses they have incurred.
  • Equity participation maximizes control and share of profit
  • Eventually, the host country can develop the required skills for mining the resources themselves
  • This is a great way to reduce fiscal deficits

Disadvantages of the contract

  • International interference in the operation can increase the cost of oil in the country
  • There are inherent risks of wrong estimation of the volume of resources present in the mines
  • Endangered environmental situations could be compromised without proper relocation practices

What Happens in Case of Violation?

Material breach(1) of contract can occur when the IOC fails to comply with development plan, or breaches other terms of sale and relocation agreement. The agreement may be terminated with immediate effect, without cure, in case of breach of contract. Any collateral offered or security meant as reserve may be auctioned off to recover the cost of restoring the environment or completing the extraction process. Specific sanctions or penalties may be placed on the company. The state can be given the authority to prevent the use of suboil in case of a breach of contract

The extraction of resources has to be done on a large level due to which the risks are also increased. Understanding the inherent risks and constant contest of assumptions of mineral presence is critical to the successful extraction of resources.